By having a better understanding of your tax situation, you are more likely keep more of your hard-earned money, which can also mean you don’t have to rely as much on exuberant investment returns.
Moving to another state in order to potentially save money in taxes can have a huge impact on your finances in retirement by allowing your money to go further, which means less stress on your income producing assets throughout a potential 20–30-year retirement.
In this episode we discuss the various tax implications you’ll want to know when deciding where to enjoy your retirement years!
More specifically, I discuss:
- Some of the major tax differences between states
- How income taxes differ between states
- How different states tax different types of retirement income such as Social Security, IRA/401(k) distributions, pensions, and capital gains
- State tax nuances of Health Savings Accounts (HAS)
- State deductions, credits, income exemptions, and property tax exemptions
- Sales tax differences between states and localities
- Property tax considerations when making a move
Resources From This Episode:
Previous Related Episode: Financial Considerations for "Snowbirding" in Retirement
The Key Moments In This Episode Are:
00:00:00 - Understanding Tax Situation
00:03:08 - Consider Other Forms of Tax
00:07:01 - State-Specific Nuances
00:11:53 - Tax Benefits and Strategies
00:16:40 - Retirement Tax Planning Considerations
00:17:35 - Myth of Buying Property in Tax-Free States
00:20:39 - Tax Implications for Business Income
00:23:38 - Property and Sales Taxes Considerations
00:28:19 - Importance of Comprehensive Financial Planning
Having a better understanding of your tax situation, you are much more likely to keep more of your hard-earned money, which can also mean that you don't have to rely as much on exuberant investment returns over time. Moving to another state in order to potentially save money in taxes can have a huge impact on your finances throughout retirement by allowing your money to go further, which means less stress on your income-producing assets throughout a potential 20 to 30-year retirement.
Hello everyone, and welcome back to another episode of the Retired-ish podcast. I'm your host, Cameron Valadez, certified financial planner. And today, we are talking about state taxes. Now, while deciding to relocate to a different state won't necessarily affect any federal income taxes that you pay, there can be many advantages when it comes to other forms of tax savings. Of course, I wouldn't encourage you to upend everything you own and move to another state just to save in taxes.
Like we've said before, don't let the tax tail wag the dog. But if there are other legitimate reasons in your life to possibly relocate somewhere else, you should add tax planning into the picture. Whether that's snowbirding like we discussed last episode, trying to figure out which residence will be your primary, or just relocating in retirement to be closer to family, or to have a change of culture, or, more commonly, to ease the financial burden of a more expensive state that you're not emotionally attached to. When initially exploring the idea, most people will simply just do a Google search to see which states don't tax income at all whatsoever and then decide which has the better weather in order to make their final decision, which intuitively makes sense. But I think that would be a mistake.
The reason for that is simply knowing whether or not the state imposes any income tax and what that state's highest income tax rates are. That really doesn't reveal the whole story. There's much more to it. Just because a state imposes income taxes doesn't mean that you will actually be paying much, if any at all. And that's because it depends on the amount of income you have year to year, where it comes from, deductions and credits you're entitled to, et cetera. And taxes don't stop at just income taxes. There are many other versions of taxes that you need to be aware of.
That's what we're diving into today. Hopefully, this helps you become better prepared to make decisions should you decide to relocate or just to get you thinking in the right direction. So let's get to it. First, a couple of big things you want to keep in mind. Some states may have low to no state income tax, but their sales and property taxes may be significantly higher than others. And hopefully, this doesn't surprise you too much. But again, it all depends on your exact circumstances.
And by the way, you don't need to understand the tax code of all 50 states. Just having some additional awareness of what to look out for can possibly add several more states to your list that you may have otherwise been deeming unaffordable.
For instance, you have states like Illinois, where there is a state income tax, but it isn't too high compared to most. However, the cost of living in many areas and some of the local property taxes can be very high compared to most other places. Then you have states like Hawaii, which does have some of the higher state income tax rates, but it's Hawaii, and those who have the means to retire there go there because it's Hawaii. Taxes aren't the main factor in that decision. So again, taxes may not be a major concern here if you're someone who can easily afford to live there.
It's also worth repeating that if a state does impose income taxes, depending on your income credits, deductions, and other factors, you still may not even have to pay state income taxes throughout your retirement, which could allow you more flexibility when looking for that dream retirement home or having more flexibility in your discretionary spending. This is exactly why doing the proper planning ahead of time, and again, I will repeat that because it is so important ahead of time with your team of advisors is so crucial. Don't think the only way to leave California, let's say, and save money in taxes is to suck it up and go to Florida, Texas, or Nevada, to name a few. You may have other options. That being said, let's take a look at some of the major tax differences between some of the various states.
Don't worry, I'm not going to go over all 50, just some examples to give you an idea of how they can all differ. The most popular thing people want to know is what states don't tax income at all because, of course, that's the best-case scenario for your money, right? Especially if you have a lot of income. The states that currently don't impose income taxes in no particular order are Alaska, Florida, Texas, South Dakota, Nevada, Tennessee, Washington, and Wyoming. If you're already located there and you plan to stay, or if you know that's where you want to retire, federal income tax planning will be your main focus, not so much state.
However, if you live in one of those states but have income being generated from a state that does have income taxes, that's not the case, and you definitely will need to do some careful planning since you will likely need to be reporting income to that state and filing a return there as well. Another state becoming very popular amongst soon-to-be retirees is Arizona. My guess is that there are different variations of weather based on where you go in the state, and some of their laws are a little bit more friendly compared to close neighboring states like California again, for example.
Now, when it comes to taxes, Arizona does actually impose a state income tax. But in fact, just recently, in 2023, this decreased to a flat tax of two and a half percent, which isn't bad compared to other states. In fact, that's very low, and that's only if your taxable income is high enough to be taxed in the first place. It used to be around 5%, I believe, prior to 2023. In addition, property taxes are fairly reasonable in Arizona as well.
Okay, now let's look at the other state-specific nuances that many people fail to consider. Now, of course, I don't blame the vast majority of people for not knowing these things ahead of time. No one expects you to know all of the intricacies of the different states and their tax laws, yada, yada, yada. But the other reason why some of this stuff gets missed is that if let's say, you have a tax professional that you work with within your current state, or maybe you do your taxes yourself in software online, they may not understand another state's laws very well since they may not prepare returns for those states, or maybe only a few. And the software isn't necessarily going to give you advice on that either, and have you capitalize on certain things depending upon your exact situation.
So don't expect all of this planning to just be magically done for you. The first one I want to go over is that many states exclude Social Security benefits from taxation, but they may tax all other forms of income. And shockingly, California is one of those states. And Missouri just changed its laws to start exempting Social Security income starting just this year in 2024, which is nice. This is super important because Social Security often ends up being a primary source for a retiree's income, whether they initially need it or not.
For many, it's their only source of income in retirement. The cool thing is that as of right now, many states, I believe 41 and good old DC, don't tax Social Security benefits. I also believe Nebraska stopped taxing them or will stop taxing them in 2025 as well. And if you aren't aware, depending on your other income sources, the federal government may not tax your benefits either, or only a portion of them, at worst. The states that give you absolutely no leeway on the taxation of your Social Security benefits are Utah and Montana, which is quite unexpected for many people, so be sure to do your homework.
A second little nuance that may help to understand is that certain states that do tax income may have flat tax rates versus what we call marginal tax rates. And we can actually use states like California and Arizona, again, as an example. Similar to federal taxation, California taxes your income at different marginal rates compared to a state like Arizona, where I mentioned taxes income at a flat tax rate of two and a half percent. So in California, for example, how much you pay in state taxes depends on how much taxable income you're making.
Depending on your income and whether or not you have sound retirement income planning, you could theoretically be living in California and still pay no state taxes or at least much lower rates than California's maximum rates, which are currently between 13 and 15%. Other than Social Security, another big concept that's often missed is that there are several states that exclude IRA, 401(k), or even pension income, or at least partially, but they will tax your other forms of income. Three states, Illinois, Mississippi, and Pennsylvania, don't tax retirement distributions at all from retirement accounts. They also don't tax Social Security. So if you're one of those retirees who will be primarily living off of Social Security and, say, your IRA or 401(k) nest egg, these states could be a great option for significant tax savings.
Most of the states that partially exclude certain retirement account distributions or pensions have different rules and parameters, and some offer very generous exclusions while others do not so much. Some even base their exclusions on a per-spouse basis, and some don't. As an example, there are some states that will offset any retirement distributions excludable from income by the amount of Social Security excludable from income. In layman's terms, this means that there could be strategies you can implement to save in taxes, such as delaying Social Security and then accelerating some of those withdrawals from your retirement accounts beforehand. Or if your state has a per-spouse exclusion, as I mentioned, you might plan for some sort of split between retirement withdrawals so that you can each maximize your exclusions.
Very cool stuff. It's possible that a couple that has over $250,000 in retirement income from Social Security and retirement account withdrawals and pensions would theoretically pay $0 in state income taxes in around twelve different states. So again, know where your income will come from and consult with a knowledgeable professional before making a commitment. Then comes the treatment of assets that aren't considered retirement, assets that are subject to what we call capital gains, whether that be the sale of a business, selling real estate, or maybe investments in trust accounts and other regular brokerage accounts that are not retirement accounts. Certain states tax these capital gains and nonretirement income differently, which is important if you're going to have fairly large non-retirement accounts.
This is typical for those who end up inheriting money, selling property or a business, again for a large windfall, and for those who will be reinvesting any of those proceeds. It's especially important for high-income earners who max out retirement accounts regularly and simply build up their own large non-retirement accounts. Those with company stock awards like stock options and restricted stock units. I know there are a lot of people out there who are working for some of these big tech companies, and these are very common. It even applies to lotto winners.
In these cases, taking a total return investing approach and living off that income in a state with no state taxes could be huge. For example, South Carolina excludes 44% of long-term capital gains from taxation. This could mean tens or hundreds of thousands in savings, if not more, over a 20 to 30-year time period. On the other hand, you have a state like New Hampshire, which chooses to only tax income from interest or dividends, at least until 2027, I believe. But if that is a significant source of your retirement income, then that may not be very beneficial for you in the short term.
So if you are one of those people who sold one or multiple businesses or maybe just live off of a large inheritance or other windfall, New Hampshire may not be the best for tax purposes in this example.
Now, one really quirky rule I want to touch on is in regard to HSAs or health savings accounts. So if you have an HSA, pay close attention. Many people don't know that states like California and New Jersey will actually tax any income or capital gains earned inside of the HSA on an annual basis. Even though it is widely thought that you shouldn't owe any taxes in these accounts. They also don't allow you to deduct your contributions into the HSA on your state tax return, which is the opposite in the rest of the states.
Now, this negates a lot of the benefits of an HSA in the first place, but only at the state level. You can still get the tax benefits at the federal level. So, in my opinion, there can still be many legitimate reasons to have one of these, even in these states, if they make sense for your situation. I don't blame people again for not knowing this, since there's no tax form that your HSA provider is going to send you come tax time showing that you earned income throughout the year.
It's more of a manual process you have to do yourself. And many tax preparers don't have this on their checklist either, so it's often missed. Or if you do your taxes yourself, you definitely need to be mindful of this nuance. There is nothing that is going to tell you to do this process. You just have to know.
So if you live in one of these states and have an HSA, you need to know this because, at the end of the day, it's you who is responsible for your taxes, no one else. Even if you use a professional preparer. I can't tell you how many people I see that have an HSA, sometimes in the six figures, and there's nothing on their state tax return regarding income received or any potential capital gains in the account, which can definitely become a huge problem in a potential audit down the road. Just know that if this is you, there are strategies you can use to minimize this tax hit.
And the last couple of things I want you to know about the differences between some of these states is that many states offer additional exemptions, deductions or credits on your state income tax return if you're over certain age thresholds. And again, each state is different. These potential deductions and credits are usually geared towards retirees who are age 65 and older in some instances, and some are per person. In addition, always remember that each state can and often does change its tax laws and rates or income brackets. This includes income taxes, sales taxes, property taxes, et cetera. Don't think your tax situation is set in stone and that you'll always pay the same amount in any given tax.
The good news, however, is that states sometimes lower their income tax rates. In fact, in 2024, there were twelve states that actually reduced their income tax rates. In a world where everything seems to be getting more expensive, it's hard to imagine that that could happen. But it does.
Okay, moving right along here. Oh, another common question many people have that still might be earning some sort of income is that they ask, in what state am I responsible for paying income taxes if I have more than one home or I have a business in another state where I don't live a majority of the year, or maybe not at all. This question refers to one of those very common myths that people often rely on and actually a subject brought up very often in our office. It's that you can just buy a place to live in one of those tax-free states we mentioned earlier, and now you won't pay state taxes on any of your income, even though you still may maintain a home in, say, California, for example. Not so fast. It's not that simple.
For example, if you live in California, you can't just buy a small place in Florida or Nevada or something and act like that's your main residence when you actually spend most of your time in California. Now, there are many things people try to do to make it look like the place in the tax-free state is their main residence, but it's not likely to fly if your real home state of residency or domicile audits you and you're trying to just cut corners for tax purposes. I mentioned some of these examples in the previous episode, where we talked about your residency. If you decide to snowbird, such as changing your license plates, your mail, your voter registration, et cetera, these things are some of the legitimate things that you do need to actually change. But just doing one or a few of them is not enough.
In addition, every state, and this is very important to know, has its own laws on how to completely move your residency or domicile to that state. So always consult a competent attorney on this, especially for states like California and New York. By the way, I have heard from multiple tax attorneys that these high-tax states like California and New York will likely audit you if you start doing some of this stuff, especially if you have a very high income. The point is, don't try and cut corners or cheat the system. If you're going to move for tax purposes, you have to actually move and spend over half of your time in the new state, preferably most of your time, if not all.
Now, the other part of that question, or usually what follows, is what if you actually move to a state with no state income taxes, but you still earn income from a business? This would include rental properties, by the way, located in your previous state that does have a state income tax. What are the potential tax planning implications here? Well, in this case, you're still going to owe state income taxes to your previous state on that income that is earned in that state. This is yet another one of those myths that people often believe. Again, I will use California because it's just such an easy example.
And this is where they think that if they maintain their business, let's say, in California, but they move to Texas and work from home, then they don't have to pay California income taxes. Wrong. You're earning that money in California, so they will try and tax it. As I said, the same goes for real estate rentals. If you have, say, five rental properties in California, and you're considering a move to Texas to avoid state taxes on that rental income, think again.
In order to save state taxes in a situation like this, you would generally need to have your real estate in Texas. In addition, if you sold any properties located in California but you live in Texas, those would still potentially be capital gain income in California, subject to taxation in California. In general, the tax planning rule of thumb is that if you make money in a state that imposes an income tax, you're likely to owe taxes there on that specific income. Moving to a tax-free state will save you in income taxes on the money made in that tax-free state. In addition, if you do a full move and establish a domicile in a new state, you will likely still owe some state taxes to your previous state, at least initially for part of the year in which you make the move. This all depends on what was earned and when your new domicile officially took place.
So usually, the first year or two are a little unique. Actually, I want to throw a caveat in there because you may be thinking, well, what if I'm getting a pension from my lifetime of work in a state like California, but then I move out of state? What then? Well, in the case of a pension, there's actually a federal law that prohibits any state from taxing the pension income of non-residents, even if the pension was earned in that state. So if you earned your pension in California but then moved to Texas, your pension income wouldn't be subject to any California state taxes and none from Texas since they don't impose state income taxes, which is a good thing.
But let's say you move from California to any other state that imposes a state income tax, maybe at a lower rate than California, and you have an income you're generating from California. You will generally be eligible for a tax credit to offset the amount of taxes that you owe in California. This gets a little bit more complicated. If you've got two different states and they're both taxing your income, definitely consult with your tax professional.
Let's move on to the other types of common taxes that I mentioned earlier. Other than income taxes, people tend to miss when making a move. And again, the two big ones are property taxes and sales taxes.
Property taxes can be a huge factor when deciding to relocate. Do not underestimate this. However, just like anything else, this is going to depend particularly on your exact situation. For example, if you bought the property many years ago in another state as maybe a vacation home or a rental, and you plan on fully moving into that property, it likely won't have much, if any, impact. If, however, you're approaching retirement and you want to maybe sell your current residence that you bought, say, 25 years ago for a much lower price than the price of homes today, and you want to buy a new residence in a different state, things may change significantly, as in property taxes may go much higher because they are based on the assessed value of the property, which 25 years ahead of time is likely to be much more expensive, even if it's the same square footage or maybe even smaller. However, on the other hand, your particular state may have certain provisions that allow you to move within the state between different counties and receive a property tax benefit.
One such example would be Prop 19 in California. There also may be some property tax exemptions that can reduce the property taxes you pay once you reach a certain age, depending on your locality's rules. Be sure to look into these, as they may not apply to you automatically. And be mindful of the property taxes in the new area you plan to live in, not just at the state level, but at the local level.
One example that catches many by surprise is Texas. They are attracted to the fact that there are no state income taxes, and maybe they can buy a little bit more of a home there for a similar cost, but later come to find out that the property taxes are very high compared to most other states.
Next is sales taxes. Sales taxes may apply to most goods we purchase, depending on the state we're in, such as food, clothing, gas, and other goods. There are some states that even tax some services, not just physical goods. It's worth mentioning that there are currently five states that do not impose sales taxes, and they are Alaska, New Hampshire, Delaware, Oregon, and Montana.
That leaves most of the US subject to sales taxes, so it's a good idea to be mindful of them when you're considering a move. However, sales taxes, just like anything else, don't stop at the state level. There are many local municipalities that may impose their own sales taxes, that you'll also want to be aware of. Sales taxes shouldn't be generalized as one tax. There are, actually, multiple versions of sales taxes.
For example, there are 13 states that still tax groceries. Now, most people who live in states that never taxed their groceries assume that there is some federal law that food can't be taxed whatsoever, and it's just not true. There are even a lot of states that don't tax groceries at the state level, but there may still be a local tax on them. In fact, I often see that local taxes are more significant than the state's own sales taxes if they have one. The good news, however, is that a lot of those states do at least offer some sort of tax credit to help offset some of those taxes paid.
In summary, no matter your situation, use these hypothetical examples we've discussed as guidelines for your tax planning when choosing your home in retirement. Always consult a professional tax advisor and attorney prior to making a move, and make sure you understand each state's specific rules on how they tax different types of income, at least just the states that you're looking at and how that state determines domicile. At the end of the day, where you decide to enjoy retirement will ultimately depend on what makes you happy. Taxes shouldn't be the most important consideration, but they are, of course, a good filter when deciding between multiple areas, especially for those of you who will continue to have a very high level of income in retirement. And remember, the more you save in taxes, the more discretionary income you will have to spend and enjoy in retirement and the less stress on your investments over time. This is why financial planning, or at least comprehensive financial planning, is very important.
Don't just focus on things like investments. There are other components that may lean on the investments or vice versa and take some of the stress off of one or the other.
So that does it for today's episode. Remember that it's 2024. That being said, we have a new 2024 tax cheat sheet as a free gift for download when you join our Retired-ish newsletter. This will provide you with the important tax numbers and thresholds for your personal tax and financial planning throughout 2024.
In addition, if you check out our website at RetiredishPodcast.com, we are offering a free download for my firm's retirement planning quick guides, which includes multiple flowcharts and resources to help you make decisions and implement some of the things we discuss on the podcast. So be sure to check that out. If you want more insight or help to prepare for your dream retirement and to learn even more about making your retirement and tax planning more efficient, feel free to connect with us at RetiredishPodcast.com. Or just send us an email at firstname.lastname@example.org. You can also ask a question to me personally that I will answer anonymously in a future episode.
If you can spare a minute and find this information actionable and insightful, please subscribe to or follow the show on your podcast app and share it with a friend who you think might benefit. If you would like to learn more about the topics that we discussed in today's show, you can find the links to the resources we have provided in the show notes right there on your podcast app, or you can just visit us at RetiredishPodcast.com/36. Thanks again for tuning in and following along. See you next time on Retired-ish.
00:30:22 - Disclaimer
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